The defined-benefit (DB) pension has long been referred to as the Rolls Royce of retirement options, so in some ways it’s fitting to see it has become a (silver) shadow its former self.
With a DB scheme, your employer promised that in exchange for four decades of service – and 40 years of contributions – you could see out your days on a pension equal to up to two thirds of final salary.
That was then. The demise of the job for life and increased longevity has resulted in a dramatic shift to defined-contribution (DC) schemes instead.
Much less onerous for employers, with these you still get all the benefits of generous tax reliefs on contributions, but can only count on getting your accumulated contributions back – and those of your employer – plus any investment growth at retirement.
According to a survey undertaken by the Irish Association of Pension Funds (IAPF) earlier this year, in nine out of 10 cases where a defined-benefit scheme closed, it has been replaced by a defined-contribution scheme. The balance is made up of personal retirement savings accounts (PRSA) and hybrid structures.
While the loss of a coveted DB scheme is difficult for many employees, on the plus side the survey found employers are contributing generously to replacement schemes. Of the new schemes established, it found, the maximum employer contribution rate exceeded 10 per cent in half of the schemes, with 8 per cent of employers contributing more than 15 per cent of salary.
In 44 per cent of new DC structures, the employer matches the employee’s contribution, usually up to maximum of 10-15 per cent of salary. In total, 86 per cent of schemes paid more than the traditional, typical contribution rate of 5 per cent.
The IAPF Defined Benefit Survey 2018 examined 65 companies with more than 60,000 members. It found 20 per cent of companies surveyed still had a DB plan in place, which is open to new entrants and future accrual of benefits.
About 74 per cent of companies have legacy DB arrangements in place which are closed to new members, with half of these being closed to future accrual. Some 39 per cent of closed DB schemes have removed future service accrual for existing active members.
‘Matching’
The survey found “matching” to be the most common employer/employee contribution structure (44 per cent). With this, the employer will increase contributions to the scheme where the employee agrees to increase theirs. The employer will usually pay up to a maximum percentage of salary, typically 10-15 per cent, with the employee contribution usually being less than that.
Most other employers (38 per cent) have committed to contribute a level/fixed-rate contribution, typically somewhere between 5-12 per cent. The balance of the DC replacement plans operate either age-related, grade-related or service-related contribution structures.
More than 63 per cent of schemes surveyed had de-risked their investment strategy, effectively future-proofing benefit for their members. Speaking of the findings, Jerry Moriarty, chief executive of the IAPF, says: “While a default investment strategy is in place for 96 per cent of DC schemes in the run-up to retirement, the options for employees at retirement have broadened. There is a clear trend of a move away from the simple, traditional annuity and/or cash strategy at retirement, with funds now offering a variety of different member-specific glidepaths at retirement.”
While no one talks of DC schemes as luxury vehicles, there are upsides. "It suits some people more than others," says Brian Kingston of Investec.
Where someone’s life expectancy isn’t good, a DC scheme can at least be left to their estate. With a DB scheme, apart from a half-pension going to a spouse, on death the accumulated fund is lost.
Where a scheme is being wound up, the asset is closed and distributed to members. “Existing pensioners are looked after first, typically with the purchase of an annuity,” says Trevor Booth of Mercer. Where the employer changes from DB to DC for future service, existing employees typically benefit from a “what you have, you hold” feature.
By and large, “if you get that letter in the post, the deal is done”, says Declan Hanley of Davy. There isn’t much scope for negotiation.
Pensioners typically get their existing pensions bought out, while everyone else gets a transfer value. However, as well as closing down a scheme, employers are also trying to encourage individuals to leave them by offering a top-up payment, in addition to the standard transfer value.
‘Good transfer values’
“Generally, people get good transfer values,” says Hanley. For many, the best option then is to invest their transferred value into the employer’s DC scheme, which is typically “vanilla, cheap and cheerful and not huge risk”.
Leaving it in situ means that when you retire you will be able to draw some of it down in cash and take the rest by way of an annual annuity payment or transfer it into an approved retirement fund, where it can remain invested.
You might opt to transfer it to a new employer’s pension scheme, or you could purchase a buy-out bond, which has the advantage of enabling access at age 50.
It’s easy to be blinded by the size of the pension-pot figures. As a rough guide, at a rate of 4 per cent, for every €4,000 worth of annuity you want to get a year for life, you’re going to need at € 100,000 in your pension pot.
The options open to you as you move from DB to DC might be informed by your age and how close you are to retirement, the amount of flexibility you want or the provision you want to make for others in your family.
“If, say, you have a pension pot of €1.3 million and, on retirement, are offered a €30,000 pension, you could take it but also take out a life assurance policy for the lump-sum element in case you pass away early, to get the best of both worlds,” says Gavan Ryan of Willis Towers Watson.
Whatever you do, talk to an adviser first, he says. With DC schemes, “it has to be bullet-proof because all of a sudden you are the one carrying all the risk.”
